The Fed is likely to hike rates today

U.S. Federal Reserve is expected to announce a quarter-point interest rate hike when it wraps up its June meeting Wednesday afternoon, but that rate hike is widely anticipated and there are a few other things that could stir up markets more.

First, the Fed will issue a statement at 2 p.m., along with its latest economic forecasts and its interest rate outlook. Then Fed Chair Jerome Powell briefs the media at 2:30 p.m.

Markets will be hanging on any headlines that add to the debate about the course of Fed rate hikes. There is still a clear divide between those Fed watchers who expect another rate hike this year after Wednesday and those who expect two more. So if the Fed sounds more optimistic on the economy, raises its interest rate forecast, or even announces that Powell will hold press conferences after every meeting, any and all of those could be viewed as “hawkish.”

The plot thickens

The Fed releases its so-called dot plot, a chart with anonymous Fed officials’ forecasts on interest rate expectations. The chart currently shows three rate hikes for this year, but it’s a very close call based on the positioning of the dots, so any slight move could add an interest rate hike in December. That would be a clear message from the Fed that it is going to be more aggressive.

“They don’t need much of a change at all for the headline to say four instead of three,” said Michael Schumacher, director of rates at Wells Fargo. “The headline will be screaming and say the Fed looks for more aggressive tightening, but in reality if you look at the numbers, it wouldn’t be that much different.”

It’s the economy

The Fed is likely to bump up its forecast for GDP growth from its current median forecast of 2.7 percent for 2018. Economists currently see second-quarter growth running well ahead of 3 percent. The Fed could leave its outlook for unemployment about where it is, at 3.8 percent for 2018, which is where it was in the month of May.

The Fed could also slightly move its forecast for inflation, which is currently seeing a slight tailwind. The Fed’s current forecast expects PCE core inflation at 1.9 percent for this year, and while PCE has been under 2 percent, CPI is running above the Fed target of 2 percent.

Press briefing

A news wire story that Powell is thinking of holding press briefings after every meeting roused markets Tuesday and sent the dollar higher. Marc Chandler, head of foreign exchange strategy at Brown Brothers Harriman, says the market viewed that Dow Jones report as hawkish and as suggesting there is more scope for further rate hikes if Powell needs to meet the press more often.

Trade wars

Powell could be asked about the economic impact of trade skirmishes and tariffs when he meets with reporters. One market pro says the Fed may view the dollar impact of the current tariffs and retaliation as too small to hit the economy. But what Powell says about a potential worsening of trade friction may also be telling, particularly as some economists see the possibility of trade battles and tariffs as a negative for business spending and sentiment.

“If we get a full-blown trade war with China and tariffs on cars, we’re in a recession in 2019,” says Grant Thornton chief economist Diane Swonk. “With inflation, that’s a bad combination for the Fed.”

Economists are also listening for any mention by Powell of emerging markets and whether he expects contagion there or a crisis in Europe, started by Italy.

How they’ll hike

Economists expect to see the Fed increase its fed funds target range by 25 basis points, to a range of 1.75 to 2 percent. But it could do so by pushing up the interest on excess reserves by 0.20 percent.

That’s because the funds rate has risen to the top of its range and the Fed would like to keep it more in the middle. The interest on excess reserves, or IOER, is the interest that the Fed pays banks to keep cash at the central bank.

Specifically, the benchmark is at 1.7 percent, just 0.05 points away from the IOER. The interest rate on excess reserves has historically been a guide for the funds rate and is usually a bit above the Fed’s benchmark. But Fed officials were recently concerned the funds rate is rising more quickly than expected, causing a tightening in money markets, according to the minutes from its last meeting.

A solution suggested at the meeting was that the Fed raise the rate paid on reserves by 0.2 percent, while it hikes the funds rate 0.25 percent. This could hold back the funds rate from getting too close to the target ceiling.

“We believe the 25bp hike in the target range will be implemented by increasing the IOER rate by 20bp, thereby encouraging the effective fed funds rate to trade closer to the middle of the 1.75-2.00 percent range,” wrote J.P. Morgan chief U.S. economist Michael Feroli.

Source: CNBC

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